The RBA’s QE announcement focused on ensuring the flow of credit to businesses and households via ADIs. We think the lowering of funding costs for banks is a net positive for the institutions in the current challenging operating environment.
The opportunity
We are currently seeing ADI (major & regional banks) issued bonds trade at wide margins (higher yields) compared to a few weeks ago mainly due to the broader credit market uncertainty. As we have been noting throughout this dislocation, now is the time to return to fundamentals and add credits to portfolios that will be able to withstand the disruption over the next 6-12 months. We believe the regulated ADIs falls in this category.
Major bank issued investment grade rated senior and Tier 2 sub-debt bonds are priced at very attractive yields at the moment, but this could change very quickly when market participants come to realise that the measures announced by RBA and APRA are strongly supportive of the banks.
Using NAB as a proxy, the chart below shows how far and fast credit spreads on bank senior and sub debt have moved over the past month.
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It is not untrue to say that with the likelihood of a recession and a fiscal deficit, the Australian government could lose its AAA rating. The ratings of the 4 major banks are linked to the government’s rating. However even if the government’s rating were to be lowered by a notch, major bank senior and Tier 2 sub-debt will remain investment grade rated.
The background
The key message from the RBA yesterday was that the central bank’s focus is well and truly on credit flows to households and businesses. Banks will be used as a conduit to facilitate this flow of credit. ADIs in Australia intermediate the vast majority of financing transactions, notwithstanding the rise of non-bank lenders in the last few years.
The actions by the RBA primarily targeted cutting bank funding costs and ensuring that this flowed through to the consumer (ie not get trapped by the profits of the bank) – this will help corporate issuers with near term maturities to be able to roll these over with support of the banks.
The RBA’s announcement contained 4 key measures –
- 1. A reduction in the cash rate to 0.25%;
- A target yield on the 3 year Australian government bond;
- A term funding facility (TFF) for the banking system; and
- Adjustment to interest rates on exchange settlement balances.
Of these measures, the third and fourth specifically support banks by reducing their overall funding costs. We acknowledge the fact that a weaker economic backdrop will see a deterioration of bank balance sheets (higher loan losses), however we believe this is offset by the pseudo-government support given to banks to ensure they continue to play a key role in the flow of credit.
Conclusion
As highly rated, large, stable, well-regulated and systemically important entities the major banks are a relatively safe place to invest through times of uncertainty.
With the current dislocation in credit markets we see opportunity across the capital structure to gain above average returns for the risk being taken and encourage investors with liquidity to stand ready at short notice to take advantage of any such offers we may see.